TFD has an all-new newsletter every Friday! Sign up to get it here:

How Much You Should Keep In Your Checking Account To Follow The “Buffer” Method

December 19, 2016

As the year begins to wind down, it’s a perfect time to reflect on what went well and what you want to improve upon heading into the new year. A common goal is to start getting your finances in better order, whether that means saving more money for a goal, paying off debt, or building up emergency savings.In order to work towards your goals, a beneficial first step is to make sure your financial setup is well organized.

Before I became interested in personal finance and started tracking my expenses, my setup was much different than what I have now. I used to have one checking account and one savings account. I would keep all of my money in the checking account, except for $300 in my savings account (to avoid bank fees).

Most of the millennials I’ve talked to that are early on in their financial journey seem to have a setup that’s very similar to this, with the majority of their money sitting in a checking account and a small amount in a savings account earning a low interest rate. Sure, this setup is very simple, but it’s also far from optimal.

Back in college, I could get away with it, because I didn’t have very many bills, and my budget was essentially “spend as little as possible, with some occasional splurges.” In the years following, I got married, and we merged all of our finances into joint accounts. With increased responsibilities and additional bills, it quickly became apparent that I needed to have a plan for our money and get our financial setup better organized.

We now have one main checking account, three main online savings accounts, and our investment accounts. I’ve detailed our savings strategy previously, and now I’d like to focus on the mindset we have for our checking account.

Figure out your cash flow:

Before you can determine the right amount to keep in your checking account, there are a few numbers you need to know.

How much money are you bringing in each month? (Income)

How much money are you spending each month? (Expenses)

When do your bills get paid?

Once you know the answers to those three questions, you’ll be able to start building your plan for your checking account. Knowing your income and expenses ensures that you know how much money is coming in and going out each month, and can help you set a consistent amount to keep in your checking account.

It’s important to know when your bills get paid to ensure that the money you’ve allocated towards them in your budget is actually there when you need it. For example, if you get paid every two weeks, you need to make sure either your first paycheck can cover the bills in the first half of the month, or you’ll need to keep a larger buffer in your account to avoid over-drafting.

Here’s how this looks in practice for us:

We have two incomes, so we bring in two paychecks during the first half of the month, and then two paychecks in the second half of the month. We start every month with $3,000 in our checking account. The amount fluctuates based on when our paychecks come in and when our bills get taken out, but the lowest our account gets to at any point during the month is about $700. This amount is our buffer. Even if we overspent in our budget, this money protects us from over-drafting, and acts as a mini emergency fund.

We use a zero-sum budget, meaning that we allocate every dollar towards specific purposes. We set this budget up and track our expenses in Mint. Personal Capital is also a useful option for tracking your expenses and net worth.

All our bills and savings transfers are automated, and our bill schedule is fairly balanced throughout the month (rent and some of our bills are taken out at the beginning of the month, while some get taken out towards the end of the month).

There are a few reasons we don’t keep more than a $700 buffer in our account.

1. There’s less temptation to overspend or splurge, because we aren’t seeing a big number in our checking account. This keeps us from being lulled into the thought process of “having extra money to blow.”

2. The majority of our money is being put towards specific goals, whether that be into our savings accounts, 401ks, or debt repayment. Rather than having money sit in an account and earn zero interest, we’re maximizing the amount of money that is actively working for us.

3. It’s much more secure to not have ALL your money in one place. If your account gets compromised, you don’t want the thief to be able to have access to all of your funds. For that reason, our savings accounts are with a completely different bank.

I’m not necessarily advocating this as the BEST way of having your checking account set up, but it has worked really well for us. I would strongly encourage you to analyze your own setup and determine some steps you could implement to improve it. Are your bills automated? Would it help you be better organized to call some of your providers to switch the due dates of your bills to all be on the same day? Do you have too much of our money just sitting in your checking account?

If you find that you currently have too much money sitting in your checking account, I suggest opening up an online savings account and transferring the extra money into it. We use Ally Bank, and there are plenty of others, like Discover Bank or Capital One 360. There are a lot of good options out there, so just do a little bit of research to find a reputable company that fits your needs.

Ideally, you want to start each month with the same amount of money in your checking account, and you want to find the best balance possible for how much to keep in the account. If you don’t keep enough in there, you’ll end up over drafting and incurring bank fees. However, if you keep too much in it, you’ll likely be tempted to overspend, and you’ll be missing out on the chance to earn higher returns and reach your goals sooner.

Rather than just doing what you’ve always done, challenge everything and find areas for improvement. Take small steps consistently, and eventually, they’ll add up to big wins.